Maximising Returns from Stocks

(Why do we never seem to get the returns that long term measures seem to indicate? Our emotions lead us to do things which spoil the returns. My column in today/tomorrow editions of Deccan Chronicle– http://epaper.deccanchronicle.com/articledetailpage.aspx?id=7787639 )

ART OF SELLING

 

In one of my articles, I had talked about a ‘trading’ strategy and why it is important to follow a ‘process’ out there. I would like to extend my thought to the ‘forever’ portfolio or the long term portfolio. I understand that I am probably talking in to a vacuum because investors do not seem to like anything for keeps. (hopefully, except spouses and children).

 

Franklin Templeton India did a study. Two of their funds, have 3.9 lakh investors and these schemes have been around since 1993. Franklin “Prima” has a NAV of around Rs.838. These units were available at par in 1993 in the NFO/IPO. One would think that there are many investors who stayed the course. Unfortunately, less than 10,000 investors have stayed on since inception, in these two funds. And reports say that it is people who could have died or forgotten!! So much for our mindset.

 

We get mood swings. Most mutual funds gathered the most number of investors in the market peaks of 1999-2000, 2008-09 and recent times. Most people get out of the mutual funds when there are sharp falls or prolonged stagnation. Thus, very few get the ‘long term’ returns from these funds and end up with lower returns. Yes, there will be hindsight analyses of people who sold at the top, bought at the bottom and so on and got super returns. However, the thing to note is, how many of us are capable of finding out the tops and bottoms?

 

I can understand if someone panics and gets out of a single direct share he holds. But I fail to understand why a mutual fund investor should bother about the markets? Yes, you may like to increase your outlay if you think everyone is pessimistic and not do so when everyone is in love with equities. Once you understand that when everyone is happy and piles money in to the markets, the markets become expensive and ‘prospective’ returns become lower. Similarly, when no one talks equities, it is probably a good thing to add some.

 

Apart from selling a ‘single’ stock for some reasons, I would not sell or stop my SIP in mutual funds of the equity flavor. Selling is something I will do only if I need the money desperately for an emergency. I will not use this simply to buy in to another asset class. For instance, I will not bank of my mutual funds at the last minute, to buy a house. For buying a house, I will plan well. Ideally, I will shift some money out of equity mutual funds to debt funds when there is a very positive sentiment and exuberant valuations in the stock markets. We want to get the maximum possible returns. So, it needs planning to sell.

 

Do not sell out or stop investing simply because of fear. Yes, you may sell out of a company share because you fear the company will simply vanish or go under. But this is not true for a diversified mutual fund. So, why panic in a mutual fund?

 

Selling is probably a more important aspect of investment than buying. A good company can have a bad year. Our markets can have more than one bad year. We will go through market cycles. Markets are never ‘fairly’ valued. It is always a function of optimism and pessimism. Use pessimism to buy and optimism to sell. How do you know what is what? How do we distinguish? Is there anything other than ‘anecdotal’ evidence or homilies such as ‘even my driver is making money in stocks’ ?

 

One broad market indicator is something called the ‘market’ PE. It is like treating the companies in the respective indices as a single company and expressing their P/E. In the Indian context, the Sensex has an ‘average’ P/E or around 18. In the 2000 boom, it went to nearly 30 times. The lowest was around 12 times, after the 2008 crash. Currently, our Sensex is trading at a P/E of around 23.  Thus, it means that the closer to 12 it is I like to buy and the closer to 30 I should be happy to sell. This is a very rough yardstick. There are other functions like prevailing interest rates, growth in the economy and profitability of companies.

 

In general, try and use some measure for a stock or a market before you take a call on buying or selling. Have a reason other than your gut and your tipster. Hear the sounds, check some numbers. You will be surprised at the amount of analytical data floating around for free. Take some time to learn. It will help you with your wealth creation.

 

R Balakrishnan

(balakrishnanr@gmail.com)

 

March 27, 2017

 

 

TRENDSPOTTING- Chasing stocks as part of the faithful

(This appears in today’s Deccan Chronicle- A fatal attraction for the faithful, who follow what is seen and not what is known)

Following the trend is a popular thing in the stock markets. The simple logic is that if others have done it, they would have reasoned it out. And we would tend to think that the ‘others’ are experts and we will not do wrong to follow it. Often, this trend of following, becomes a ‘self-fulfilling’ one and make the experts stand out even taller.

 

For instance, if I talk good things about a stock that is relatively undiscovered, the chances are very high that there would be some follow up action that is prompt and result in the stock price moving up immediately. What happens is that the stock is very likely to be one that is not among the actively traded ones. It is also out of favour with investors. Thus, a small quantity of buying would mean that one has to find ‘sellers’. Sellers who were quiet and now they see some demand, they immediately start to ask for better prices. This price hike will continue till the supply becomes abundant and then there are jobbers and traders who start controlling the movements. If there is a fundamental story to back an upmove, probably the price would settle higher. This move, from discovery to a new range of price, happens very quickly. After that there is only sideways movement, with some false rises and falls. The early ones who got in, will get out. In a sense, the host will leave the party and leave the guests to settle the bills.

 

These moves happen in stocks of companies/industries that are seasonal or cyclical. Smart investors get in ahead of the crowd. For instance, if you take stocks of sugar companies, they went out of favour in 2014 and then languished. Small accumulation started somewhere around Sep 2015. After that it gradually inched up without much activity and on small volumes. In 2016 towards the end, ‘momentum’ investors turned to it. News reports of sugar shortage and price moves started coming in. The rally got its last legs.  And now, there is a lot of noise and churning. Trend followers are getting on to the wagon. However, I am not sure that from here, the risk-reward is favourable. The early investors got their money more than doubled in the first year or so. They may have got out in part or full. Now, it is the traders and the late entrants who are creating the action in the stocks. Now, at some point, either sugar prices will peak due to fresh supplies coming in or some governmental action. And gradually the interest will wane off as the sugar cycle moves from shortage to surplus.

 

Same things can be noticed in stocks of PSU Banks. Just take the PSU Bank index ( have used the Kotak Bank PSU ETF as proxy) and see the chart :

 

PSUETF

The same story would repeat over different time cycles for various sectors.

For example, if we take the small steel companies, we are probably half way through a trend. I am not sure how much more upside is there, but it is yet to become a roaring trend. Now news and views will get more pronounced about the sector.

 

So, how does one ‘spot’ a trend or play it effectively? Very often, we go late to the party and our short-term trades become long-term investments. Is there a way to avoid it?

 

I have some thoughts that could help contain the risks.

At the outset, NEVER forget fundamentals. And my rule to this is simple. These cyclical stocks are ‘balance-sheet’ values and ‘profit – loss’ only impacts the prices and sentiments. Ultimately, for these stocks, the balance sheet is the baseline. And to me, that defines the ‘fair value’ for these kinds of stocks. This is simply because the final product is homogenous and there is generally no unique advantage that a single player has. Low entry barriers, excess global capacities are two characteristics. Thus, a sugar mill is a sugar mill. The replacement cost or the enterprise value should be the guiding benchmark for me. So, when I buy, it will be closer or below the book value/replacement cost. I will not go just by the book value, but also look at the ‘Enterprise Value”. A very high debt is something to be careful about.

 

When buying above the ‘fair value’ put in rules. Rules should relate to;

  1. Time limit for holding;
  2. Expected profit ; and
  • A ‘stop-loss’ level.

 

These rules should NEVER be relaxed. This could result is less than maximum possible profits, but it will always prevent big losses. Even a small relaxation in rules can cause serious injury.

 

 

R Balakrishnan

 

 

Buying shares – Some basics for the beginners..

(This appears in some editions of Deccan Chronicle)

 

SO YOU WANT TO BUY SHARES DIRECTLY?

The news is that a record number of ‘demat’ accounts have been opened in the last few months. Which is an indicator that more people want to ‘buy’ shares directly as opposed to investing in mutual funds. Of course, the good thing is that mutual fund investments in equities, through the “Systemic Investment Plans” or SIPs as they are popularly known are also rising steadily. What this means is that more people are turning to equities to park their surplus monies. There is also the fact that alternate investment avenues are reducing.

 

The retail participation and enthusiasm can also be gauged from the response to the IPOs, all of which are seeing oversubscription as well as premium listing prices.

 

Financial literacy surely has gone up in leaps and bounds. People are no longer happy with the eight percent return from banks. Many friends want to know what are the things to bear in mind for a ‘first time’ investor in to direct equities?

 

It is futile to caution people against going this route, but at this juncture, if I tell you not to invest in direct equities, it will be like spitting in to the wind.

 

At the outset, I presume that you are investing that money which you do not need for a very long time. Hopefully, you already have some savings built up, your PPF taken care of etc. Equity is NOT your first saving or investment IF you have financial dependents or obligations coming up. You surely are not going to be driven to despair if you lose some of that money or even all that money.  So you are all set to take the plunge.

 

The first requirement is to ‘know’ what you are buying. This ‘knowledge’ is a loose term and includes a few attributes that I will enumerate:

  • What are you buying?
  • Why are you buying?
  • Can you sell it?
  • How long do you intend to own it?
  • If the value drops, will it hurt badly?

You are buying a share. It has a market price as reflected by daily trades on that share. It has an underlying business that has a future. That business attributes do not change every moment like the prices seem to indicate. Once you realise this, you will use the price movements to time your buys and sells. I also urge you to keep a small diary in which you list down the following:

 

  1. Why did you choose this stock?
  2. How did you decide on a price to buy?
  • What is your expectation of a price or return at the point of buying?
  1. What is the maximum loss you are willing to see on this share?
  2. What is the duration for which you initiated this trade?

I hope you do not buy simply because you heard about someone buying it. That person may have reasons you do not know about. And for him, this trade may be a fraction of his wealth. Importantly, he will not tell you in advance when he is selling. So, as the saying goes, ‘do not follow someone, because he may not be leading the way’.

 

Buying a stock, for a lay person, is like stepping in to a minefield, with blindfolds on. In a bull market, you will generally be lucky and seem to be making money. When the bull market turns, you will end up with shares that fall below your purchase price and you will not have the temperament to sell them at a loss. You will gradually get driven away from stocks. Get your reasons for buying on record and keep checking.

 

I would urge beginners to make a short list of quality companies (even if you do not do financial analysis) and adopt a SIP approach to direct equities. You can build up a high-quality portfolio of stocks. HQ stocks are those companies which are large, been around for long time, have good brand/reputation, pay regular dividends, have no debt etc. When you step down the quality ladder, you are better off if you know the company well enough and take an informed investment decision.

 

One important thing is to try and figure out the long-term prospect of a business and visualize the scale it can reach in years to come. It is important that what you choose is capable of being in the top three or four players in an industry over time. If not, your returns will be poor. Remember that in India, market returns will not vary far away from the GDP growth number you see plus the inflation. That will be an “average” return. The choice we make, can be on either side of the average.

 

R Balakrishnan

February 22, 2017

 

You want to invest in Stocks?

One of my early pieces

Simplify Investing
What is the temperament of a successful investor?
To be a successful investor, one does not need a high IQ. You need not be a wizard at mathematics or finance. One of the most important attributes of a successful investor is ‘temperament’. I understand that the word is being loosely used and can mean a range of things, given its origin from Latin, where it simply means ‘correct mixture’.
What is meant by temperament here is the uncommon attribute of ‘common sense’. A proper temperament for investment would mean that you are not excited simply because you are with the herd or against it. You know you are right not because of what someone else says or thinks, but because you have made sufficient efforts to understand the facts and you have reasoned right.
Sounds simple, does it not? Alas, each one of us has weak moments where we let reason take a walk and our actions get dictated by the latest expert we hear and the price movements that create emotions of euphoria or panic, greed or fear. I am sure, most of us can narrate stories of the stocks we bought when our faculties were suspended or some great stocks we sold out early because some ‘expert’ talked us out of it. Our temperament just weakened.
Investment in stocks is not rocket science. You do not have to be an expert in financial analysis. You can use a disciplined SIP (systematic investment planning) approach or, if you CAN, time your investments to a price which you feel is right. There are some things which are contra-indicators of a fit temperament. I will try and list a few of the common temptations, or mistakes, we make (experts included) that result in not getting proper mileage from our investment vehicles.
i) Never think that ‘this’ year is going to be different from any other year. What it means is that bullishness is the natural attribute of media and stock-brokers, analysts, etc. Do not listen to them; stick to your discipline or philosophy. If you are into your SIP, unless any fact, on which you based your judgement, is wrong OR things have changed permanently for the company you picked, there is no reason to head for the door. It is very difficult to sell a stock that has shot up and hit a new peak and then to buy it back at a lower price. You could get lucky; but, most likely, what will happen is that you would miss out on the total returns from the stock.
ii) Do not worry about whether the markets are likely to go up or down. No one gets it right; each one of us has a 50% probability of being wrong. Sticking to our convictions and attitude helps us here. Markets will fluctuate. Leave day-trading and short-term-trading to those who have time to watch the market without blinking their eyelids and who have made it a hobby, or habit, to trade. They are traders in prices and not investors in stocks.
iii) TIMING the market is tough, even for experts. For instance, our Indian markets are predominantly driven by FII investments. In addition, liquidity in stocks is poor. And government policies are capricious, leading to overnight changes in moods and sentiments. So, even if we have our company analysis right, we do not know whether the market has peaked or bottomed. Ignoring timing can make us much better investors. For instance, if I like HUL as a company and am happy buying it at, say, Rs700 to Rs750 per share, my focus should be on that on not on the index. If my conviction on HUL is right, it does not bother me too much if the stock price falls below this level. Timing becomes difficult, because history does not repeat itself. At each moment, the environment keeps changing; new sets of investors keep coming in; and government policies, world economy, etc, are but few factors that are never precisely in line with the past. Markets do not stay for many moments in a ‘perfect’ equilibrium where everything is fairly priced. Over-pricing and under-pricing can last for very long periods and tend to change your mindset to a bull or a bear!
iv) Knowing what to buy is 90% of the problem solved. I am sure, most of us spend some time in deciding which shoe to buy or even which belt to buy. And you do some homework, or use your knowledge bank to make your choices. We would rarely buy something new without knowing what it is. The same is the case with stocks. If you are the kind of investor who buys simply because someone told you to, then you do not have the temperament to be an investor. You must know what the company does and some understanding of why it makes money. Even if your financial advisor, or your best friend, tells you to buy a stock, please understand this. Peter Lynch, one of the investment gurus, says, “Never buy something you can’t illustrate with a crayon”!
v) Short-term and long-term: Warren Buffett likes to invest ‘forever’. To me, it means that the money I choose for investing in stocks is that ‘pocket’ of money which I am not going to ‘ever’ need in the next 10 years or so. I am afraid to invest any money in stocks if I know that the money is needed for sure within a given time. To me, this aspect of the ‘temperament’ is perhaps the most important one. There are very strong reasons for this approach. If we put our money into stocks, that money is at the mercy of factors that are outside our control. We may have chosen the ‘best’ possible investment, but we have no control over market prices or market sentiment. For instance, when we definitely need the money, if a global crisis, or a scam, hits the market, no investment will be guaranteed to survive. Any investment should be such that we are able to enter and exit at OUR choice of timing and not compelled by time to pay more or realise less. That is why I get worried when people start equating ‘long’ term with precise terms like one year, three years or five years, and so on.
So, investing in stocks needs your time as well as temperament. Analyses can be best done by you. Remember, most of the so-called professional ‘advisors’ and ‘analysts’ have been in the business, or industry, for less than two decades. Similarly, at least half of today’s investors would not have spent more than 10 years or so in the markets. So, in a sense, it is a congregation of the ‘blind’, where the pulpit is being pounded by the blind to an audience that cannot see too well either.
The other key attribute to a good temperament is to be NOT INFLUENCED BY MEDIA OR ANALYSTS. They have a vested interest in always being ‘bullish’. Given their nexus with business and industry, it hurts them to write, or speak, negatively or about selling down their stocks. They are what Peter Lynch refers to as the ‘DON’T WORRY, BE HAPPY” crowd. Honest views are rare and they are not found alongside lots of advertising. Many in the media are simply ignorant too.
Choose well, pause before investing, and pay some attention to what you are buying. Once you tick your checklist, stay invested.

MONEYLIFE FOUNDATION

Sucheta & Debashish have pursued “Financial Literacy” with a passion. Moneylife Foundation was set up to help common (and some uncommon) folks fight the demon of financial scams and problems. It has completed SEVEN YEARS.

I would like to share with the readers of this blog, a mail sent by Sucheta

 

Dear Friends,

 

Greetings. Let me start by thank all the Moneylifers from Mumbai who were with us on 4th February for an inspiring and englightening afternoon, listening to Baijayant ‘Jay’ Panda and Rajeev Chandrashekar, Members of Parliament (MPs) on Transforming India: Thinking out of the box.

 

The event marked, Moneylife Foundation’s 7th Anniversary and I am happy to share that our membership has swelled to over 59,200 members. We still have a long way to go before policy makers take us seriously and engage with us before making policy decision.

 

You do not need to be a Mumbaikar to benefit from what we do. The Moneylife channel on YouTube has crossed 1.2 million views. You can either subscribe to the Moneylife channel on YouTube, or better still become a Member of Moneylife Foundation, so that you get updates on all our events, their coverage as well as access to our extremely valuable Tax Helpline, Credit Helpline and Legal Resource Centre. It is all free. We will upload our event videos in a day or two, but you can read the coverage here. While you are on the page, subscribe to the Moneylife daily newsletter to keep track of issues that mainstream media is often reluctant to cover. Thanks to the support of Ashish Chauhan, MD & CEO of the BSE, we had for making this historic convention centre, which was the former trading ring of this 141 year old exchange for our 7th Anniversary.

 

For the first time this year, we also organised a tour of the BSE, a film about its history and a talk on the SME incubator for some management students. Write to us at foundation@moneylife.in if this and other events interest you. If there is enough interest among Moneylife member, we will request the BSE for a tour.

 

Last year, we started Daily Guidance Clinics, to offer FREE, one-to-one counselling, on non-finance related issues as well as a number of talks on a diverse range of issues including transport, toll problems, solid waste disposal, noise pollution, cell tower radiation, social audits, the municipal budget, app-based solutions to civic issues, Yoga, the Mumbai Development Plan and many more. Write to us with your suggestions for more.

 

One request that we have already taken on board is to organise more talks on police related issues. We will announce plans from time to time.

 

We are most obliged to all the activists who have made the guidance sessions as well as helplines possible by generously sharing their expertise with members.

 

Allow me to share an excerpt from a lovely email that I received from Mr Virendra Jain, founder of Midas Touch Investors Association, whose public interest litigation has led to historic wins for investors – in getting promised returns from mutual funds in the early 1990s and later, initiating a massive investigation into fly-by-night companies, which he labelled “Vanishing Companies” in the 1990s.

 

 

Dear Sucheta,

 

My grateful thanks and best wishes to you, Debashis, and to all those who have made Moneylife Foundation a fantastic organization in seven years by their dedication and selfless service.

 

I would be brief but would like to make few comments on this happy occasion.

 

MLF has done pioneering work in holding seminars, among others, on: “Protection of investors” as well as educating them on “basic principles of investing”, in a lucid, easy to understand language. But, the effort has not got the appreciation and recognition it deserves, especially from the authorities. It is country’s loss.

 

MLF programs are generally available on net while those sponsored by authorities –Securities & Exchanges Board of India and Investor Education and Protection Fund (IPEF)– spend tens of crore annually but do not have one program to show on their website. Actually, the quality and participation in seminars would have been exposed, had they done so!

 

Compare this with programs under SEBI: 15,708 programs covering 11 lakh participants (as on 31 January 2014 since inception in July 2010) have been conducted across various target groups (school children, college students, middle income group, home makers, executives, retirement planning and Self help groups).

 

IEPF under the Ministry of Corporate Affairs, which had a corpus in this fund of over Rs1,273.66 crore as on 26 February 2016, conducted /sponsored 2,291 Investor Awareness Programs in 2015-16. But, their quality of their program is extremely poor and they don’t have one video to show for it. Logically, they should sponsor MLF in a big way on their own.

 

Lastly, I think MLF should strive to turn the organization into an Institution. My experience is that: It’s an uphill task, but do-able.

COMMODITY STOCKS- Tread with caution

 

 

TIMING ELEMENT IN COMMODITY SECTOR STOCKS

(This appears in today’s Deccan Chronicle )

I have always held that commodity sector stocks do not do very well over a long term. Companies that are in the manufacturing sector in commodities (as opposed to trading) have to be asset heavy. For example, setting up a cement plant would cost around US $ 120 to 140 per tonne of installed capacity. In rupee terms, it is around Rs.8500 to 10.000 per tonne. Cement sells at approximately Rs.250 per bag of 50 kgs or around Rs.5000 per tonne. Thus, at the product level, even if they make ten percent as net profits, it just is a return of 5% on the capital cost. Cement is one industry that is still doing well in India and not so cyclical. We have not had instances of cement industry being in the red for prolonged periods, thanks to our economic growth. However, if we take commodities like steel, aluminum etc we have seen such cycles.

 

Let us take the example of Sugar. It could cost around Rs.15,000 per tonne of crushing capacity of cane. With a yield of around 10% as sugar, the cost of setting up a mill is approximately Rs.150 per kg of sugar produced. Again, the economics are not too good. I am not even talking about cane prices, power etc.

 

Every commodity sector has a similar story. The world cannot do without these companies or industries, but these do not get remunerative returns. This is because there is no great competitive advantage or technology edge. Thus, producers keep selling at marginal pricing, merely to survive.

 

This industry survives on marginal cost pricing. The manufacturing plants are quite robust and have a long life. Thus, older players have lower fixed costs to recover and they set the pricing in the market place. This means that some player or the other keeps getting in to financial problems leading to contraction of supplies at some point. Global capacities, demand, supply and government policies also impact prices and demand/supply changes. The fortunes of these industries swing like a yo-yo.

 

Stock prices of commodity companies move in anticipation of end product prices or key input prices. Plus there is a question of global demand factors. In most commodities, China has become the biggest consumer as well as producer. So their economy does impact global commodity prices in a big way.

 

Demand for commodities at consumer level is generally steady and rising in line with population growth. And global capacities for most commodities exceed demand. Each commodity may have some domestic regulatory factors also. For example, Indian sugar industry is still regulated by the government dictating a minimum support price for sugar cane. The availability of cane is dependent on our rain gods. Thus, given the capricious monsoons, the sugar industry swings between surplus and deficits. Surplus cane and sugar naturally result in bad times for the sugar industry. Earnings drop and share prices crack. Sometimes, the stocks fall in to a long period of depression.

 

Just take the long-term price chart of any sugar company and you will see. High stock prices in 2006, 2009 and 2016 and years of stagnating low prices in other years. I see that most sugar company prices have more than doubled in the last one-year or so. And now the sugar prices are moving up now. It is likely that the markets have anticipated firm sugar prices and stock prices moved up before the earnings did. If I scan the quarterly results, I see that the quarter ended June 2015 was particularly bad for the sugar companies. And most sugar stocks hit their recent lows in August of 2015. To buy then, one should have had the insight to predict that the worst was over. I, for one, had no clue.

 

The only way to take a call was to keep tracking the price to book value of the sugar company stocks. Taking a five to ten year history, there will be a trend in the Price to Book number. When it is near the lows, it is good to buy and exit when it is near to its historic high. Looking at the P/E ratios will put us away and make us buy at the wrong time. Share prices of commodity companies generally tend to turn lower from at round seven to ten times peak earnings. These are trading calls and can give great returns, if we follow a process and stick to it. I am using Price to Book simply because these businesses have universally available technology and there is almost no product differentiation.

 

 

 

 

 

BUDGET 2017

( a long piece- on budget making as well as this current one)

Budgets are wonderful things. They create so much flutter before they are presented and then a lot of debate. Industry captains uniformly praise the budgets (with some brave exceptions like Rahul Bajaj). Others will praise or condemn the budget depending on political leanings and some personal preferences or prejudices.

 

Before every budget, the stock markets start to go up. They like to forecast which sectors will get some bird droppings from the budget. And then of course, there will be hasty ramp up in prices of some stocks where the punters place their bets.

 

THE FUDGET MAKING EXERCISE AND SOME THOUGHTS:

 

I like to call the document as a ‘FUDGET’. This annual document is the annual report and accounts of the national exchequer. Unlike traditional annual accounts of a company, this document is not audited. And there are no uniform accepted accounting standards. Each year, the mandarins who prepare this complex document, will invent some new classification or measure. Their objective is twofold:

  1. To manage expectations of global lenders and investors; and
  2. Manage expectations of the general public.

Of course, there is something called “Fiscal Responsibility” which is mentioned whenever convenient.

 

In any household or business, the objective is that we should live within our means. But the nation never does something like this. In a house, if I have a temporary shortfall, I can borrow. But I have to repay it as promised. And, no one will keep on giving me loans indefinitely. Here is where the politicians, bankers and the sovereign budget score. In the last sixty odd budgets, I do not think we have ever lived within our means. We have created a mountain of borrowings that will be the burden on the next generation. And the government can also ask RBI to freely print more currency notes. The government can also ‘borrow’ money by issuing bonds. It is wise not to ask if the government of India can ever repay its debts. The total stock of outstanding debt simply keeps on increasing year after year.

 

So, there is no point in looking for the budget deficit number or any other big number. It is just arithmetic. The real issue is that the debt mountain keeps growing and as banks, insurance and FIIs have more and more money, they will keep ‘investing’ more and more in to debt issued by the government. Of course, we must not forget that in addition to central government, each state government also is part of this financial wrecking crew. Debt is truly forever. And the world is happy with the system where government profligacy finds takers in the form of fixed income investors. Of course, the sovereign has the highest credit rating when it comes to domestic currency.

 

BUDGET OF 2017-18

 

This budget is finely crafted and treads a middle path. I will not go in to the numbers or the various ‘yojanas’ that do not seem to appeal to most of those who will be reading this.

 

At the outset, every budget, whether household or sovereign, is based on the premise that one should live within the means. Both the sources and the uses keep expanding and it is always a struggle to make one equal to the other. Unlike an individual, a sovereign has the luxury of perpetually being in ever increasing dollops of debt. There are limits to it, beyond which the economy collapses in to becoming a poor state with hyper inflation and misrule, To this extent, we have been fortunate that over the last decade or so, fiscal discipline is talked about and boundaries are generally observed.

 

This budget sticks to the boundaries of prudence. Fiscal deficit at a modest 3.2% (could become lower if some schemes do not spend everything/revenues are more than expected or could slip if some revenues do not materialize as expected) is manageable given the ownership of the printing press. Economic growth numbers will be shy of eight percent but in today’s global economic situation, anything above five or six is good. Our economic growth is also a function of our entrepreneurial capability, our native intelligence and our fortunate failure to make global trade a big issue. Inward looking is perhaps turning out to be an ugly blessing that has stunted our growth over years, but saving us from pain at this juncture when the world is turning from free trade to protectionism. It is ironic that China is now advocating free trade to America!

 

What I liked in this budget are:

  1. Announcement to do away with the FIPB;
  2. A call to State Governments to do away with APMC in respect of perishables (read vegetables). This is interesting. Will help new aggregators and cold chain companies to deal directly with farmers and sell to the consumer/retail outlets. Filing forms, paying two percent cess for the State doing nothing has been the sole function of the APMC. In addition, the APMC creates a cartel of intermediaries who deprive revenue to the farmer and push prices up for the consumer. Companies like Reliance Fresh can directly enter in to Contract Farming and give better and cheaper produce to the consumer.;
  • A five percent lower rate of taxation to companies with turnover less than Rs.50 crores is a welcome step. These companies are the true start-ups and entrepreneurs that create jobs. A big boost;
  1. The disincentives for cash business with lower rate of income tax on digital or cheque transactions will improve the tax base for sure. This is a far reaching step;
  2. The lowering of limit for cash donations to political parties is a good beginning
  3. Making it unlawful to deal in cash for transactions above 3 lakh in value is another good move to lower the circulation of black money;
  • Raising the threshold of compulsory audit for professionals to Rs.2 crore per year is a good move.

What I can see is that while there is an attempt to clean up and tone up the tax administration system, facilitate small and medium business and boost in government spending, they have not given in to resorting to ad hoc measures to boost revenue. Given that there are uncertainties on GST, they have not tinkered with the Service tax rates. Yes, we can always argue for more administrative reforms.

 

Today, the economic circumstances of India are wobbly. Just as we were getting healthier, the world is becoming more inward looking and each country is having its set of problems. Globally, there is a slowdown and global capital flows are kind of afraid. The US, with a radical leader at the helm, is having every one on edge. Suddenly, everyone is realizing that a healthy and prosperous US is a precondition for world growth. Even China has to stand up and lecture US on free trade! In this environment, where our largest export earning industry (IT) is facing headwinds and low Oil prices threaten the remittances in foreign currency, it is important that our economic policies give a nudge to capital flows. They also have to encourage domestic asset building. For example, our steel industry, which was in the doldrums thanks to dumping from China, is looking up once we imposed anti-dumping duties.

 

At the end of the speech, the first reaction was, “Is this a budget at all?”. Then came the feeling that budgets ought to be like this. Reforms are a continuous process. Budget is after all akin to a business plan. I hate to go in to the numbers because then it becomes a “Fudget”. I do not want to go in to the fine print and dig in to the numbers. It is impossible, even in this digital age, to prepare a precise statement of affairs. And given that the previous budget period still has two months to go, the extent of ‘estimation’ is very high. So let us leave the numbers aside. What will be real is the final government debt that will get added up. And it is a rising number.

 

Given that the budget came after the much-debated ‘demonetisation’, there would have been a logical temptation for Mr Jaitley to be very populist. That he has resisted the temptation itself is a big positive. This budget is only the beginning of the current year. The implementation of GST is the event of 2017 that I am looking out for.

 

Given that a budget score will start at five on ten, I will give this one seven on ten. For being boring and for brining in incremental administrative reforms.

 

 

 

Celebrities Endorsing Mutual Funds

I recall that SEBI had clearly denied this to the industry, many years ago. The only argument that AMFI could put in support was that the insurance industry is doing it. When insurance itself is a bad product, the mutual fund industry should be playing on the weakness of insurance as a product. Alas, many sponsors are in both businesses and that is the problem. This is why AMFI, instead of opposing celebrity endorsements in insurance, wants it for MF also. For sponsors who are in both businesses, they will not take a stance against insurance. There lies the irony. No one has any genuine concern for the investor. Remember that AMFI is an industry body. So they represent the interests of the owners alone.

(Below appears in ET Wealth, Today)

Indians love to hero worship. For them, celebrities are like what the pied piper to the rats. Celebrities in India earn far more than their global counterparts when it comes to endorsement revenues even though the revenues generated by the products may not be as high. This high payout is because of their extraordinary power to draw people in. Imagine the pull that stars like Rajanikant or Amitabh or the Khans have over their audiences. They can sell anything.

Celebrities do not understand financial products sufficiently to endorse them. Just go back to recent history to look at the “Home Trade” where a sportsman and a film star endorsed the brand and the outcome is well known. The important thing to understand is that the celebrity is far wealthier than the average person. Even if he is invested in the product he endorses, the proportion of his money invested in the product will be a very small fraction of his total wealth. The unsuspecting investor will be lured big time in to products that he does not understand.

Celebrity endorsement for the industry is tolerable. Endorsing specific fund houses or specific products will lead to unethical selling practices. Endorsement of specific fund houses will mean that the richest AMC will end up spending the most and get an unfair advantage. Thus far, SEBI has imposed strong controls on the mutual fund industry (sometimes to the extent of impracticability) and permitting celebrities to endorse MF products/Houses will be retrograde and contrary to its intent of providing investor protection. And, given the affordability factor, it will distort the level of the playing field further.

 

Optional add:

 

R Balakrishnan

(balakrishnanr@gmail.com)

January 25, 2017

 

RETURN OF INVESTMENT

(this appears in today’s Deccan Chronicle   http://epaper.deccanchronicle.com/articledetailpage.aspx?id=7223761)

 

(Sharing some experiences in collecting my own money on maturity)

Long-term investment is an essential part of one’s financial planning. It could include things like PPF, insurance products (hopefully you will NOT have any insurance investment product), long term bonds, fixed deposits, company deposits etc. This time I do not want to talk about investment selection or return on investment but focus on a mundane thing like return OF investment.

 

When we invest, the entry is very easy. All rules are relaxed, the salesman helps with filling the forms, taking your cheque, doing the running around and then get you enrolled in to the scheme. KYC requirements are waived or partly exonerated. The sellers of products and their agents are at their best behavior when they collect your money.

 

Some investments can run durations of forty years. For example, it could be a PPF with five extensions of five years each. You can deposit your money physically or electronically in to your account. Over the course of these years, you will undergo changes. Physically, geographically and so much that your signature of forty years ago may be even forgotten by you. When it comes to collecting maturity proceeds, PPF is funny. Each bank has its own set of rules. For example, when I closed someone’s PPF in Bank of Baroda, it was a simple process. I had to give a self-certified PAN card, proof of Bank account and the request form signed. The payee’s banker verified the signature. The Bank did not mind the fact that someone else submitted the request for closure of the account. The proceeds were sent to the beneficiary’s account by RTGS. No pain at all.

 

State Bank of India has a different approach. They want the beneficiary to physically visit the “Home” branch (the branch where the account is). Re-submit all KYC forms and then the maturity proceeds will come. This talk of ‘anywhere banking’ and digital age does not make sense to them. In forty years, if you have left the city, you have to spend money and spend a few days to complete the process. Here, the process is open ended and can be quite a nightmare if you are one of those who cannot be bothered to fill up forms, submit documents etc. My advice is that in the last five years, when you apply for your final extension, please make sure that you transfer the account to a branch that is located close to where you stay. So that becomes the “Home” branch. Make sure you resubmit the documents including your signatures etc. I hear that SBI is generally kinder if you have your personal account with the bank. That will help you to collect your maturity proceeds. And yes, during the life of the PPF, make sure you have ‘nominated’ a beneficiary. And if you have nominated your mother as your nominee when you opened the account and then you got married, change the nomination.

 

With traded investments, it is generally easy. Fixed Deposits with companies unfortunately need to be discharged (keep the original receipt. Surrender it a fortnight before maturity after signing across a revenue stamp etc to the broker or the office of the company) and you need to preserve physical records. Some of the companies will issue cheques or drafts for repayments, so if you have changed homes, fresh proof will be demanded. In bonds, most issuers give you the “Demat” option, which makes life simple. Proceeds move in to our bank accounts on maturity or sale.

Insurance investments are a tricky area. The agent who sold you the policy is unlikely to be around when the maturity happens. You are on your own. Here I had very good experience with LIC of India. They understand and can solve practical issues without creating too much fuss. However, with private insurers, it can be a nightmare. I had a not very good experience with PNB-Metlife. They wanted me to physically come to their branch, submit PAN card copies, blank cheque leaf and photographed me!! Luckily I remembered the maturity date, so I went to them after being bounced off walls when I spoke to their call centre. The original agent had ceased to be one, Metlife refused to give me another one to help out and when I asked them to stop paying commission to the agent, they refused. So be prepared to face rough times. Private insurers try to delay. Also, their branch office was not empowered to disburse, unlike LIC where the branch handles the claims. Private insurance companies are poor for customers.

 

What my experiences are may not be universal. I just want you to be aware of the processes that you will have to be prepared for. Keep a “maturity calendar” for your investments and take timely action to get your money back in time. No agent or company executive will do anything unless you go and ask. Getting our money back is our problem, not theirs.

 

 

R Balakrishnan

 

NSE- IPO

(The NSE is in the news for all the wrong reasons. It has painted for itself a picture of hubris and arrogance. What this hides is the strength and the solidity of the business. Much as one may dislike personalities associated with  it, the business is solid. This column appeared, with some editing, in different editions of Deccan Chronicle on 1st/2nd Jan 2017. )

 

The National Stock Exchange (NSE) was born of the Bombay Stock Exchange’s (BSE) arrogance and hubris. NSE was a very bright kid. In a few years, it dwarfed the BSE in market shares. NSE led to the closure of a host of regional stock exchanges.

 

At the basic level, a stock exchange is a platform to facilitate buying and selling of securities. In a sense, it is a service. In debt securities, the RBI owns the trading platform, and institutional players are allowed to trade directly with each other, doing away with the broker.

 

However, the brokers ensure their hegemony by owning the rulebook.. Globally, therefore, there is a requirement that each buyer and seller trade through a broker. So, it seems unlikely that exchanges will see the end of brokers. However, with a broker or without a broker, an exchange is needed. Exchange makes it safe for trades with anonymous counterparties for shares or for money, as they ensure that payment and settlement mechanisms are put in place. Thus, the exchange as a business will survive for eternity. So long as people who want to speculate (invest, if you have strong objection to the word) exist, stock exchanges will exist. Stock exchanges have expanded their revenue base by using the same platform to encourage trade in commodities, precious metals etc.

 

At a basic level, exchanges were used as a means to facilitate trade and to help brokers survive and derive their brokerage income. In the early days, most brokers also managed their own money, and could trade on thin spreads that you and I cannot imagine today. For them, the brokerage costs were zero.

 

Today, the exchanges have their separate stream of revenues comprising brokers’ annual fees, transaction charges, turnover fees etc. It is reasonable to presume that these can only keep going higher and higher. In a country like India, we have number of companies, but thin volumes.. ADRs, GDRs etc are traded on foreign exchanges and do not deliver any revenue to the local exchanges.

 

At an intellectual level, I oppose the listing of exchanges. An exchange has to be a public infrastructure that facilitates trade at the lowest possible impact cost. Ownership by the government or by public institutions is the right model, I feel. The moment it gets listed, there will be pressure to keep improving earnings. And there will be professionals with stock options, who will also be thinking likewise. Thus, the costs of trading will now only keep rising.

 

The NSE may have had its share of controversies and corruption. At this point it is headless, with no CEO. However, the organization seems to be robust enough to carry on business without a leader. Obviously the firm will find a leader. In terms of technology and capabilities, NSE had gone ahead of BSE. The BSE could catch up, however, the NSE’s market share dominance is unlikely to be challenged for a long time to come.

 

The NSE earned profits of around Rs.1200 crores in the last full year. The paid up capital is tiny at Rs.45 crores and present reserves stand at over Rs.7000 crores. There are reports that the company would be valued upward of Rs.40,000 crores at the IPO pricing level. It is important to remember that NSE is NOT raising money for the company, but some existing shareholders are selling their shares. Given the financials, it is unlikely that NSE will ever raise fresh money, so the risk of future dilution is low.

 

Stock market trades will only keep rising. More and more securities will keep getting added. More and more instruments, derivatives will keep getting added to the range of traded securities. So long as trades keep happening, the NSE will keep making more money. Their cash flows are very strong and I would expect strong dividend payments year on year. The ROE is strong at just under twenty percent or so and it will be tough to keep raising it. If the company has a generous dividend payout policy, ROE could be maintained.

 

 

Globally, we do not have many listed stock exchanges. So there is a scarcity premium attached to this. Yes, the BSE is also slated to hit the markets soon, but then, two stock exchanges with small capital bases and limited floating stock would mean that demand will outstrip supply. In India, we have MCX that has survived a crisis that would kill a company in any industry. Being an exchange, it survives, albeit with ownership changed. And the stock trades at high valuations.

 

Exchanges will have technology risks and fraud risks always attached to them. However, given the monopoly status that exchanges enjoy globally, regulators will be soft on exchanges. For all that happened during the Harshad Mehta scam, the BSE still exists. And the NSE is going through a scandal, but looks unlikely that it will hurt its business potential.

 

In spite of the steep valuations, I will definitely add the scrip of NSE to my portfolio of long-term holdings, solely on account of its business position and its near monopolistic hold on the market. However, given India’s growth projections, it is a long time away from becoming an annuity stock.

 

Yes, at some point there will be some regulatory action or caps on charges and fees as the exchange tries to boost its EPS. I am willing to live with that risk. I am also not too worried about litigation risks, given the fact that worldwide, exchanges have never been penalized severely. NSE is the true beneficiary of industrial and economic growth, and to my mind represents one of the best proxies for the Indian economy.

Given the IPO size and pricing, successful individual allottees may not get many shares. The lot sizes won’t be big. Depending on market conditions, I would expect the issue to open at a price range that is very close to the IPO. So the strategy to buy is extremely fluid. As an investor, I will wish that the IPO does not list well so that one could pick up on listing. If there is a huge premium on listing, I will prefer to wait